This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the top of any article.

Broadening Investigation into FX Trading

How asking for "at-best price" and other common practices put corporate FX customers at risk of being overcharged.

The Department of Justice has been asking bankers and clients how much sales teams charge customers to exchange currency, the people said, asking not to be identified because the interviews are private. The move is the first indication prosecutors are probing sales practices.

According to more than a dozen current and former salespeople and traders interviewed by Bloomberg News, it’s common to charge what’s known as a hard markup, tacking on a small margin for a salesperson’s services. Some clients who make currency deals infrequently or in small amounts are known to pay little attention to the rates they get. The Justice Department is scrutinizing whether banks committed fraud by failing to disclose the practice properly to customers, the people said.

“Banks should always be transparent with their clients on pricing mechanisms,” said David Woolcock, chairman of the committee for professionalism at ACI, a Paris-based group representing 13,000 traders in 60 countries who helped write the industry’s code of conduct. “This does not sound like it is consistent with best practice nor ethical behavior.”

The Justice Department has interviewed sales staff with their lawyers at bank offices in the U.S. over the past two months, according to one of the people. The agency is one of more than a dozen authorities around the world investigating the $5.3 trillion-a-day currency market following allegations that dealers at the world’s biggest banks traded ahead of their clients or colluded to rig the benchmarks that pension funds and money managers use to pay for foreign exchange.

Banks also have been digging through their own records and interviewing staff, including from sales, to show cooperation with the probes in bids for leniency should they lead to disciplinary action.

Banks aren’t required to provide time stamps showing when currency transactions are completed, as they do with equities, giving dealers an opportunity to mislead about the rate at which orders were executed. Spot foreign-exchange transactions also fall outside the European Union’s Markets in Financial Instruments Directive, or Mifid, which requires dealers to take all reasonable steps to ensure the best possible results for their clients.

Unsophisticated Customers

Peter Carr, a spokesman for the Justice Department, wouldn’t comment about which banks or practices the government is investigating.

Former employees interviewed by Bloomberg News said sales teams at Zurich-based UBS AG and London-based Barclays Plc were aware of which companies were considered unsophisticated about currency trades and charged them more.

Goldman Sachs Group Inc.’s foreign-exchange Alpha team, which deals with hedge funds that specialize in equities and trade currencies infrequently, overcharged such clients as recently as 2011, according to two former employees at the New York-based bank who asked not to be identified. When a salesman received an order from such a customer, often by e-mail, he would execute it and wait to see if the market moved, the people said. If it did, he would charge the higher price.

The markup could be as much as 30 pips on a 10 million-euro ($13.6 million) trade into dollars, or 0.3 cent, the people said. A pip is the smallest possible price movement for a currency pair, or one-hundredth of a percentage point in the case of euros and dollars, which are priced to four decimal points.

None of the banks has been accused of wrongdoing.

“We take these matters seriously, have looked into them, and are taking action as necessary,” said Tiffany Galvin, a Goldman Sachs spokeswoman.

Aurelie Leonard, a spokeswoman at Barclays, declined to comment, as did Richard Morton at UBS.

Banks don’t charge commissions or fees for currency transactions, so their profit is determined by how much better a rate they can get than what they offer clients. While some markup is inevitable and justified, the system is open to abuse, as companies often lack the time or expertise to make sure they’re getting a fair deal and only ask for an e-mail confirmation of the order, according to the salespeople interviewed by Bloomberg News.

The process works like this: If a company gives a bank an order to swap US$20 million into pounds at 9 a.m., a salesman can pass the request to a trader, who immediately carries out the transaction, or he can do the trade himself on the bank’s electronic platform. Rather than notify the client that the trade was executed, though, the salesman may wait to see how the market moves.

If the pound rises against the dollar by 10 a.m., the salesman will contact the client and say the bank transacted the order at the best possible rate and report it at the later price, costing the customer more.

In equities markets, by contrast, as soon as an order is executed, a ticket with a time stamp and a price from the exchange is generated automatically, leaving a trail an investor can follow.

More experienced foreign-exchange customers call in their orders and insist on staying on the phone while they’re placed so they can hear them go through, the people said. Hedge funds and companies more versed in pricing would pay only 1 pip more than the actual rate, the people said.

ACI’S Woolcock said that while it’s reasonable for a bank to charge a client a margin to cover the expense of doing a foreign-exchange deal, inflating a markup not aligned with when an order was actually executed isn’t acceptable.

FX Pricing

Some clients leave themselves open to being overcharged because they ask for what’s known as an at-best price, trusting a salesman to execute the order at the optimal market rate, the former salespeople said. More savvy ones request a two-way price, which shows guaranteed rates at which a client may buy or sell regardless of how the market moves. Most corporate customers ask for at-best prices, one of the people said.

“It’s the obligation of the customer to have some kind of knowledge,” said Jason Leinwand, head of foreign-exchange trading at Metropolitan Life Insurance Co. “You can’t just go in blind: ‘Well, I don’t understand FX so I’ll have my broker do it.’ There are still significant-sized companies that won’t spend $500,000 to put a person in the chair who could possibly save you as much as $15 million a year.”

In the U.K., where the markets regulator was the first to say it was looking into foreign-exchange industry practices, the lack of time stamps has been a point of contention for more than two decades with Austin Mitchell, the U.K. parliament member who sits on the Public Accounts Committee. He met with Financial Conduct Authority (FCA) Director of Supervision Clive Adamson in March to press the matter. He said he was told the FCA can’t do anything unless someone comes forward with evidence of abuse.

Chris Hamilton, an FCA spokesman who confirmed that the meeting with Mitchell took place, declined to comment further.

“It’s vital that regulators look into this issue,” said Mitchell, 79. “This has serious repercussions for investors and businesses, and the solution is simple: Banks should provide time stamps of when they trade.”

Treasury & Risk

Treasury & Risk is an online publication and robust website designed to meet the information needs of finance, treasury, and risk management professionals. Our editorial content, delivered through multiple interactive channels, mixes strategic insights from thought leaders with in-depth analysis of best practices, original research projects, and case studies with corporate innovators.